DISCRETE PRICING AND THE DESIGN OF DEALERSHIP MARKETS

This paper incorporates institutional features of trading markets incl uding the discrete nature of the price grid and determines the consequ ences for prices and strategic behavior. Interactions between market m akers is complex: because equi librium prices are not determined by a zero-expected-profits condition, priority rules and the timing of offe rs have significant effects on equilibrium outcomes. Discreteness effe ctively limits competition and permits market makers to offer profitab le quotes. When traders first submit orders, absolute time priority le ads to the ''best'' price schedule, one which is ''better'' than that obtained From quote-driven institutions where market makers submit pri ce schedules first. (C) 1996 Academic Press, Inc.